The Deflation Monster
Wanniski, Jude
n 1995, I predicted that inflation 'S days were numbered.A year later I warned of a new, more exotic enemy deflation. Throughout the boom and bust of the late 1990s and the new...
...Stocks and bonds reacted positively...
...In the absence of a SEPTEMBER/OCToBER reference point by which to gauge an under-or over-supply of money, the Fed has to guess...
...While lowering the top income tax rate from 44 percent to 28 percent, the Reagan Tax Reform Act of 1986 had included an increase in the capital-gains tax to 28 percent from 20 percent without protection against inflation...
...The Reagan boom had begun...
...Over the next two years, petroleum exploration and investment in production and infrastructure ground to a halt...
...Financed with high-yield bonds, telecom companies like low-earth orbit satellite operator Globalstar and networksViatel,Winstar, Teligent, and 360networks are bankrupt, and many of their compatriots building the new Internet infrastructure are teetering on the edge with stocks trading for just a few dollars and bonds trading for pennies on the dol2OO...
...twelfth year of a deflation, :)ubled in value over the last ; there hit a 17-year low in i only now are its political .'aders beginning to under;t rates cut close to zero perao effect...
...Throughout the boom and bust of the late 1990s and the new millennium, I detailed this foe's attacks as it stomped its way through Asia, Russia, Brazil and the U.S...
...Since 1997, there has been a steady advance in bankruptcy rates, with a record 1.6 million filings in 1998...
...Now it ravages global telecommunications companies and capsizes every Third World economy that counts its debt in dollars, from Argentina to Zimbabwe...
...On January 7, I met with Dick Cheney in his transition office near the White House, to warn him that the Bush administration had inherited an economy with a rare disease curable neither by Federal Reserve interest rate cuts nor by the timorous and dilatory series of tax rate reductions then being proposed by his administration...
...In April, I gave the same warning to Treasury Secretary Paul O'Neill, and to SenatorTrent Lott, who was then majority leader...
...Although the Crash of 1987 was due at least in part to the newly expressed view of Fed Chairman Greenspan that the dollar was overvalued, on the Wednesday before the Crash, I had spent an hour at Treasury with Secretary Baker, bringing the urgent message from Professor Mundell that the dollar must be protected at all costs, even by selling bullion from Fort Knox if that is what it took...
...Still, I celebrated the Baker initiative because I knew it would have to lead eventually to a focus on gold as the key reference point for the world's monetary authorities...
...T he current deflationary process in the U.S...
...First there was the Plaza Accord, an agreement at the Plaza Hotel in New York City among the major finance ministers and central bankers that was intended to coordinate monetary policy in a way that would lead to a gold-linked system...
...One hundred percent wage reductions, also known as layo~, are frequent...
...Now it ravages global telecommunications companies and capsizes every Third World economy that counts its debt in dollars, from Argentina to Zimbabwe...
...Deflation--a significant ndersupply of money relLtive to demand--is first 6gnaled by a fall in sensitive commodity prices, which can change rapidly in highly liquid "spot" markets...
...Here we are again, though, puzzling at the odd behavior of the financial markets, debating whether the dollar is too strong or too weak, and not quite realizing how heavy a price is being paid by everyone on the planet for not having a fixed standard of value...
...Corporate defaults increased to $58 billion in the first half of 2001, with the important telecommunications sector accounting for $16 billion...
...Like inflation, it occurs when a central bank--in our case, the Fed--fails to match the supply and demand of money in the marketplace...
...No, I just want you to stop the deflation, or all the dollar debtors in the world will go bankrupt...
...I did not like the idea of a "basket" of commodities because the prices of the goods in the basket would change from one minute to the next, causing the unit to inflate or deflate...
...In late February, I advised my Wall Street clients that, until the problem was corrected, there would be no reason to buy equities.The adjustment to a monetary deflation takes time, but it is inexorable, forcing all nominal prices to fall--including the price of wages, assets, and all goods and services, even the price of haircuts...
...farm and energy economies, and later as it crashed into Wall Street and SiliconValley...
...On January 7, I met with Dick Cheney in his transition office near the White House, to warn him that the Bush administration had inherited an economy with a rare disease curable neither by Federal Reserve interest rate cuts nor by the timorous and dilatory series of tax rate reductions then being proposed by his administration...
...twelfth year of a deflation, :)ubled in value over the last ; there hit a 17-year low in i only now are its political .'aders beginning to under;t rates cut close to zero perao effect...
...Unfortunately, a month later, the initiative was completely washed away by the October stock-market Crash on Wall Street...
...The 1981-82 Reagan recession was the worst since the 1930s and almost destroyed the economy and his presidency...
...began in late 1996 when the dollar price of gold and all other commodities began to fall...
...Corporate defaults increased to $58 billion in the first half of 2001, with the important telecommunications sector accounting for $16 billion...
...In 2000, more than $40 billion in corporate debt went unpaid, a record until this year...
...Indeed, although cuts in tax rates are entirely positive for the econospurring the demand for money...
...n its simplest form, is non:aring debt of the governacquire more money, eco:tors give up "goods" or which is why gold and sencommodity prices react to changes in the demand dollar liquidity...
...Gold was at $310...
...Deflation--a significant ndersupply of money relLtive to demand--is first 6gnaled by a fall in sensitive commodity prices, which can change rapidly in highly liquid "spot" markets...
...In 2000, more than $40 billion in corporate debt went unpaid, a record until this year...
...The problem, I told him, was a pure monetary disorder that would cause serious damage unless corrected...
...T he current deflationary process in the U.S...
...The experience should have persuaded policymakers even then that a floating unit of account could do deflationary as well as inflationary damage...
...Monetary policy had been twinned with tax policy, both going in the same direction...
...Over the next two years, petroleum exploration and investment in production and infrastructure ground to a halt...
...Deflation is especially destructive to debtors, who are committed to paying down their debt with more valuable dollars out of incomes that shrink because of declines in the prices of things they produce...
...Inflation can push real capital-gains tax rates above 100 percent on long-held assets, as the tax shifts from real gains to spurious inflationary increases in valuation...
...One hundred percent wage reductions, also known as layo~, are frequent...
...In one of many misleading signals whereby monetary ease and monetary tightness mimic each other, the sudden deflationinduced scarcity pushed the price to $35 per barrel in 2000.This, after the global economy had emerged from the Asian crisis against a backdrop of diminished crude supplies...
...n 1995, I predicted that inflation 'S days were numbered.A year later I warned of a new, more exotic enemy deflation...
...Since 1997, there has been a steady advance in bankruptcy rates, with a record 1.6 million filings in 1998...
...In 1997-98, the pivotal price of oil plummeted from $25 to $10 per barrel...
...The car leasing business is in turmoil...
...Throughout the boom and bust of the late 1990s and the new millennium, I detailed this foe's attacks as it stomped its way through Asia, Russia, Brazil and the U.S...
...I called Fed Chairman PaulVolcker, on St...
...Financed with high-yield bonds, telecom companies like low-earth orbit satellite operator Globalstar and networksViatel,Winstar, Teligent, and 360networks are bankrupt, and many of their compatriots building the new Internet infrastructure are teetering on the edge with stocks trading for just a few dollars and bonds trading for pennies on the dol2OO...
...Nor could there be an inflation or a deflation of any currency linked to the basket...
...In late February, I advised my Wall Street clients that, until the problem was corrected, there would be no reason to buy equities.The adjustment to a monetary deflation takes time, but it is inexorable, forcing all nominal prices to fall--including the price of wages, assets, and all goods and services, even the price of haircuts...
...As the most monetary of all commodities, gold's large stock relative to its flow protects it from such gyrations...
...Like inflation, it occurs when a central bank--in our case, the Fed--fails to match the supply and demand of money in the marketplace...
...You want me to inflate...
...It worked very well at the outset, with the dollar/gold price rising from $280 in early March to $330 three months later...
...9 THE AMERICAN SPECTATOR n 1995, I predicted that inflation 'S days were numbered.A year later I warned of a new, more exotic enemy deflation...
...banks...
...In the absence of a SEPTEMBER/OCToBER reference point by which to gauge an under-or over-supply of money, the Fed has to guess...
...In April, I gave the same warning to Treasury Secretary Paul O'Neill, and to SenatorTrent Lott, who was then majority leader...
...farm and energy economies, and later as it crashed into Wall Street and SiliconValley...
...In one of many misleading signals whereby monetary ease and monetary tightness mimic each other, the sudden deflationinduced scarcity pushed the price to $35 per barrel in 2000.This, after the global economy had emerged from the Asian crisis against a backdrop of diminished crude supplies...
...Losses for General Motors, Ford, DaimlerChrysler, and other auto finance companies could total $18 billion over the next few years...
...Patrick's Day 1982 as I recall, practically begging him to ease monetary policy by buying bonds with newly created dollar liquidity...
...If a dollar or a Deutschmark or a yen had to abide by the reference point, their cross-exchange rates would not change, and there could be no argument about one or the other having a trade advantage...
...From the outset the monetary adjustments enshrined in the Plaza and Louvre Accords suffered from contrary tax and monetary signals from Washington...
...In 1997-98, the pivotal price of oil plummeted from $25 to $10 per barrel...
...The car leasing business is in turmoil...
...Losses for General Motors, Ford, DaimlerChrysler, and other auto finance companies could total $18 billion over the next few years...
...There was nothing he could do until the political establishment realized that conventional medicine would not work...
...IfA=Bas - ket and B=Basket and C=Basket and D=Basket, then A=B=C=D...
...As economic expansion led to Reagan's landslide re-election in 1984,James Baker III moved from the White House to the Treasury, swapping jobs with Donald Regan, the former chief of Merrill Lynch, who was less interested in financial reforms than in effec6ve administrati• move was a good one, leading to the major Reagan tax reform of 1986 and a Baker initiative in early 1985 to inch toward a gold-linked standard...
...n its simplest form, is non:aring debt of the governacquire more money, eco:tors give up "goods" or which is why gold and sencommodity prices react to changes in the demand dollar liquidity...
...The deflation ended by accident in the week ofAugust 11,1982, whenVolcker was faced with a crisis in Mexico, which could not pay interest on its $80 billion in debt to U.S...
...he asked incredulously...
...There was nothing he could do until the political establishment realized that conventional medicine would not work...
...He had to tell the Reagan Treasury he could no longer worry about the money supply because he had to monetize $4 billion in Mexican peso bonds.The price of gold rose $56 that week and the financial markets skyrocketedmbonds, stocks, the S&P 500, with Nasdaq out front...
...9 THE AMERICAN SPECTATOR for money, however, the Fed was still fighting a decade-long inflation when deflation had suddenly become the problem...
...Bank of America will take a $1.25 billion charge in the third quarter to exit this business because of rapidly falling prices for used cars...
...Affecting the value of every asset in the economy, the higher capital-gains rate was having a day-by-day impact on all marginal business decisions...
...Indeed, although cuts in tax rates are entirely positive for the econospurring the demand for money...
...Plaza was followed by the Louvre Accord, which was intended to ease the world toward a formal system that would be automatic, in the sense that each bank would manage the supply and demand for its money without having to consult each other or the money markets...
...The net effect was a steady decline in the demand for dollar liquidity that portended a new siege of infla~6 THE AMERICAN SPECTATOR 9 SEPTEMBER/OCToBER 2OOI...
...The problem, I told him, was a pure monetary disorder that would cause serious damage unless corrected...
...Bank of America will take a $1.25 billion charge in the third quarter to exit this business because of rapidly falling prices for used cars...
...began in late 1996 when the dollar price of gold and all other commodities began to fall...
...Deflation is especially destructive to debtors, who are committed to paying down their debt with more valuable dollars out of incomes that shrink because of declines in the prices of things they produce...
Vol. 34 • September 2001 • No. 7
